Climate change is one of those issues that companies have long considered ambiguous, with a solely ecological long-term impact. No more. When the European Union (EU) introduces its Emissions Trading Scheme (ETS), aimed at reducing atmosphere-damaging carbon emissions, companies and investor relations officers throughout Europe will finally have to see climate change in financial terms.
Under the new scheme, due to be implemented on January 1, 2005, companies in the electricity, oil and gas, mining and metals, cement, and pulp and paper industries will have allowances set by national governments that limit their carbon dioxide emissions.
The financial impact will have both a positive and a negative side. Companies that want to exceed set levels of CO2 emission will have to buy allowances to cover the excess, which will increase their costs, while firms using less than their CO2 allowance will be able to sell the surplus. Companies outside the sectors covered under the ETS will also feel the financial impact from the expected increase in electricity prices as a result of the stricter restrictions on cheaper energy sources such as coal.
As Richard Gledhill, global leader of energy corporate finance at PricewaterhouseCoopers, says, ‘The system is a market mechanism designed to reduce CO2 emissions. CO2, like any other commodity, is going to have a market price that fluctuates, and companies will need to decide on a trading strategy, and communicate that to investors.’
So what kind of information will companies need to provide? According to David Russell, an advisor on responsible investment to the Universities Superannuation Scheme (USS) and a steering committee member of the Institutional Investors Group on Climate Change (IIGCC), corporates will need to let investors know how they are managing changing circumstances, and what they are doing to manage any potential downside – or upside. Energy-efficient companies will be able to sell their surplus, resulting in a positive impact on their bottom line. For IROs, this situation could be a significant communication challenge, or an opportunity.
‘How companies respond to climate change and communicate their strategies will mark out the winners from the losers in the years ahead,’ notes Tom Delay, chief executive of the Carbon Trust, a not-for-profit company set up by the UK government to raise awareness of climate change issues.
Communication gap
For now, however, it seems many companies and investors remain in the dark. Peter Scales, chief executive of the London Pension Fund Authority (LPFA) and chairman of the IIGCC, says, ‘Most people know what climate change is, but the majority of funds don’t comprehend what it means for them, and what impact it could have.’
The IIGCC is hoping to raise the level of awareness of climate change implications throughout Europe. According to Russell, one reason for the lack of awareness is that the issue is seen as long term. ‘People think ‘climate change’ means things will change in 20 or 30 years’ time,’ he explains. ‘But as a result of the ETS, in the short term it will affect the performance of the companies we invest in, and that is a concern to pension funds and fund managers like ours.’
One of the problems of communicating this issue is the difficulty in quantifying a company’s involvement in the trading system and the impact of increased electricity prices. But this kind of thinking is erroneous because, although the allowances for carbon emissions are yet to be announced, governments have nowreleased draft allocation plans, giving companies ballpark allowance figures.
These figures allow companies to loosely work out whether they stand to lose or gain from carbon rationing, by evaluating a trading strategy. This makes carbon rationing different than many other corporate social responsibility (CSR) issues, in that a bottom-line impact can be measured. As Russell notes, ‘Climate change is perhaps the CSR issue that comes closest to having a direct and quantifiable value impact on companies.’
In flux
And now is the time for companies to consider these impacts and communicate them to investors. ‘If you go back twelve months,’ says Scales, ‘companies were thinking, Climate change could have an impact, but we’re not sure what, so there’s nothing we can do. Now, many more firms can make themselves aware of the potential impact, although they still might not be sure how to evaluate it. But that’s what they need to be looking at over the coming months.’
There is still much uncertainty surrounding the issue, as allowances have yet to be finalized, and the impact on electricity prices isn’t yet known. As Gledhill notes: ‘This a new market, and no-one yet knows how the market is going to behave.’
What is crucial in this period of change is that companies show they have undertaken some assessment of what the risks are. ‘Individual companies are best placed to work out how this trading scheme will affect their operations and investment plans,’ says Gledhill. ‘But for investors, it’s harder to understand. They are able to see the macro developments of what CO2 restrictions will mean for an industry, but what companies need to do is articulate to the investment community how they are going to operate within the ETS, and what their strategy is.’
Forward planning
One company that has shown foresight on the issue of climate change is Swiss-based concrete manufacturing group Holcim. Bruno Vanderborght, Holcim’s VP of environmental research and development, explains the company has been looking at the issue of carbon rationing since the Kyoto Summit in 1997. Following the summit, Holcim employed an external consultant to assess the potential impacts for the group; the consultant advised the firm to start preparing for carbon restrictions.
In 1999 Holcim established its CO2 task force, chaired by Vanderborght. When it published its first CSR report in November 2002, it included a section on carbon rationing implications. But investors were not that interested, says Vanderborght: ‘Our CO2 emissions weren’t seen to be of financial interest, especially because at the time there were no legal obligations.’
Over the past six months, though, Holcim’s IRO says investors have become increasingly concerned about CO2. Fortunately for him, the firm is in a strong position to address any investor concerns, thanks to years of preparation. ‘It’s easy for us to explain and communicate what we’re doing in this area,’ notes Vanderborght.
As a global group, Holcim has to prepare not only for the EU-wide ETS, but also consider preparing for regulation in other geographical areas. The ETS applies only to companies in the EU but the rest of the world could be indirectly affected if global firms with operations in Europe find those operations fall under the ETS.
Canada is planning to introduce its own cap and trade system and, in the US, several states have been applying pressure on companies to be more carbon constrained. Large US state pension funds have also started looking at the issue, and last November the Investor Network on Climate Risk (INCR) was established, with the aim of actively encouraging the US investment community to address climate change issues. In Australia, there is discussion among pension funds, insurance companies and some fund managers about setting up a similar organization.
As Europe adapts to carbon rationing, IROs based elsewhere can benefit from watching how companies deal with the cap and trade system, and pick up tips for if – and when – the system is introduced in their home territory. ‘Many US firms are being pragmatic about this,’ says Russell, ‘despite the lack of federal regulation. They realize they will have to face carbon constraints at some point.’
Useful web sites on carbon rationing
The Carbon Trust
https://www.thecarbontrust.co.uk
Helps businesses cut carbon emissions and capture the commercial potential of low carbon technologies. Operates an investor engagement program
UNEP FI
https://unepfi.net/
The finance initiative of the United Nations Environment Programme. Engages financial institutions in dialogue onsustainable development
IPCC
https://www.ipcc.ch/
The Intergovernmental Panel on Climate Change established by the World Meteorological Organization (WMO) and UNEP to assess scientific, technical and socio-economic information on climate change, its potential impacts and options for adaptation and mitigation
UKCIP
https://www.ukcip.org.uk/
The UK Climate Impacts Programme helps organizations assess how they might be affected by climate change
The Hadley Centre
https://www.met-office.gov.uk/research/hadleycentre/index.html
The Hadley Centre for Climate Prediction and Research is part of the UK’s Meteorological Office
CERES
https://www.ceres.org/
US coalition of environmental, investor and advocacy groups working for sustainability. CERES has done work on the fiduciary case for considering climate change risks
Pew Center on Global Climate Change
https://www.pewclimate.org/
US body providing information, answers and innovative solutions to address global climate change
Tyndall Centre for Climate Change Research
https://www.tyndall.ac.uk/
UK center for trans-disciplinary research on climate change
DEFRA
https://www.defra.gov.uk/environment/climatechange/index.htm
UK government’s Department for Environment, Food and Rural Affairs
IIGCC
https://www.iigcc.org/resources.aspx
Institutional Investors Group on Climate Change
